ECB decision: Back in September

The economist view – Melanie Baker, Senior Economist

As expected, the European Central Bank (ECB) kept rates on hold. The statement kept to the same guidance language we’ve heard from the ECB before, emphasising data dependency and no pre-commitment to a particular path:

“The Governing Council … will keep policy rates sufficiently restrictive for as long as necessary … will continue to follow a data-dependent and meeting-by-meeting approach … In particular, its interest rate decisions will be based on its assessment of the inflation outlook … the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.”

No move expected today, but September more open

The ECB was widely expected to keep rates on hold today, having only just cut interest rates in June and in line with recent ECB commentary. According to President Lagarde in the press conference, the proposal presented by Chief Economist Lane (keeping policy on hold, but also retaining a data dependent meeting by meeting approach and not pre-committing to a particular path) was accepted unanimously by the Governing Council. However, economists have also been expecting the ECB to cut interest rates further later in the year. At their September meeting they will have more data and analysis to go on, including an updated set of ECB staff forecasts. President Lagarde acknowledged that, saying that it “is going to be a bit of a busy summer.” She said that discussions were a story of “on the one hand, on the other hand” at this meeting, but also that they will have a lot more information “in the current weeks and months.” She said the question of September was “wide open.”

A September rate cut still sounds like a reasonable central case

The statement acknowledged progress on the inflation front, pointing out that most measures of underlying inflation were either stable or edged down in June; that the inflationary impact of high wage growth had been buffered by profits. In response to a question, she also sounded relatively dismissive of the risk that pay growth would not decline, sounding very confident that what they were seeing in recent pay data contained an element of catch up to higher prices and that the impact was heaviest this year; that once the catch up was completed the process would return to a more normal path. Referring to wage growth: “On the basis of everything that we see, the direction in 2025 and 2026 is downward.” She said, “I am not going to entertain the hypothesis where all that would be wrong. Because there is too much corroboration of our assumptions.”

Another 25bps rate cut would still leave ECB policy in restrictive territory in my view.

Warning shot on fiscal?

On the fiscal side there was emphasis from Lagarde that they welcome the Commission’s recent guidance calling for states to strengthen fiscal sustainability.

Key data to watch

Key data to watch in coming months will continue to include pay-related indicators and inflation figures, including services inflation which has been surprisingly sticky. In terms of ECB expectations for headline inflation, they expect inflation to fluctuate around the current level over the rest of the year then decline towards the target over the second half of next year. I have pencilled in several more rate cuts into my forecasts before the end of 2025, including two more in 2024. But that remains a data dependent forecast that assumes activity data is not ‘too hot’ or ‘too cold’ and that inflation-related data paint a gradually more reassuring picture for policymakers.

The government bond investor view – Gareth Hill, Government Bond Senior Fund Manager

Having cut rates by 25bps (0.25%) at their last meeting in June 2024, very little was expected of the ECB in their July meeting. It could be argued that perhaps the June rate cut was somewhat premature given the resilient data going into that meeting and the upward inflation revisions from the ECB staff, but having given such a strong signal to the market that a rate cut was likely, they had little choice but to follow through on that market guidance and cut rates by 25bps. Pricing for a rate cut this month was all but non-existent (less than 3% probability according to the swaps market), so the focus was really on what’s to come in eight weeks’ time at their September meeting.

ECB President Lagarde was, once again, at pains to stress that they are data not data point dependent and that there was not pre-determined path for future interest rate moves. She presented a balanced view of the incoming data, not wanting to give the market an impression that a further rate cut in September was a done deal. Questions on the impact of possible future tariffs from the US were dealt with diplomatically, as were questions regarding the re-appointment of EC President Ursula von der Leyen, though she did use this as an opportunity to stress the importance of adherence to EU-wide fiscal rules, perhaps as a nod to recent political developments in France.

Was the messaging interpreted appropriately by the bond market? Going into the meeting, the market was 75% priced for a further cut in September and post the meeting this had risen marginally to around 80%, and European government bond yields are a couple of basis points lower than prior to the press conference. The next ECB meeting is not for another eight weeks, which is a very long time in these markets and data is still proving to be sticky in a number of areas, so perhaps the market expectation for a September rate cut may be somewhat on the optimistic side.
 

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